What Exactly are You Guaranteeing?
In the 1990s, President Trump nearly ruined himself by personally guaranteeing many millions of dollars in loans, and then said he regretted guaranteeing them. But it seems he has not followed his own advice. With the NY Times releasing some of his tax records and other financial information, he allegedly is personally responsible for loans totaling at least $421 million, most of which are coming due within four years.
What does all of this mean?
Realize when you get a mortgage or a car loan you are signing a promissory note, guaranteeing you will pay it back. These loans have collateral so the lender can go after your house or car to help repay the debt if you don’t pay. Where it gets “sticky” is when there’s no collateral, which is rare when it’s a personal loan, other than credit cards, which don’t have collateral.
Small Business Owners vs. Investment Firms
When an individual or small-business owner wants a loan they usually personally guarantee it. When the loan is to an individual, say an executive buying a business, if the loan is to the person it is a legal obligation on that person, and in effect, they are guaranteeing it. If the lender makes the loan to a corporation or LLC, which most are, they ask the borrower to personally guarantee it.
When a private equity firm or similar investment firm borrows money, the partners won’t sign a personal guarantee. The same with larger corporations. So one has to wonder why lenders asked the president to personally guarantee all the loans. Not knowing the details, I can only guess it’s because they were risky loans, there was worry about non-payment, and hiding behind the corporate veil.
Interview with Greg Russell
I asked my friend Greg Russell with PRK Livengood Law in Bellevue (www.prklaw.com) about personal guarantees and here are his comments:
- He reiterated a bank will want a personal guarantee when the loan is made to an entity.
- Business sellers will want a personal guarantee as they are unsecured creditors, coming in after any senior debt, personal home equity, etc.
- A borrower with a personal guarantee must report it for any financial dealings and this contingent liability may impact the availability of credit.
- A personal guarantee can hold for a long time. There is a statute of limitations of six years, which starts from the time of the breach. Within this time the lender can get a judgment to keep the debt alive.
Interview with Bill Barclay
Lenders, of all types, have the most interest in personal guarantees so I discussed them with Bill Barclay, Regional Manager of Commercial Banking with Columbia Bank. Here’s what Bill had to say:
- 95% of Columbia Bank’s loans have a personal guarantee on the borrower. He said, “If things hit the fan, we want them walking down the aisle with us.”
- Those not having a guarantee are generally larger firms with diversified ownership and management along with private equity firms.
- If there’s not a guarantee expect tighter loan covenants that may create a personal guarantee if triggered.
- An existing personal guarantee (from a different lender) won’t have much impact on future credit if there’s only one. The bank will look at all contingent liabilities and multiple guarantees may require a closer look.
Conclusion
Personal guarantees are something business owners, business tenants, those of us in the buy-sell world, and others deal with all the time. Business buyers and other borrowers do their best to avoid them, but those with the money make the rules. I always come back to a client from about a dozen years ago who didn’t like what the bank was doing. He didn’t think they were creative or flexible enough. I commented to him, “The bank’s not in business to be creative or flexible, they’re in business to be paid back.” I know if I lent someone money I’d want as much security as possible.
